In all these fields we have progressed a long way in our ability to understand how these systems work in the majority of time. Sometimes to such an extent, that we can comfortably “build” the structure of our society on these insights. Think of constructing homes, bridges, cars and airplanes, using medicine to cure people and enhancing our ways of communication. The uncertainty that still surrounds the techniques used in these examples is limited. Confidence can be high that the benefits will always strongly outweigh the risk of incidental bridge collapses, plane crashes or unintended illness following (the wrong) medical treatment.
In other areas, our knowledge on the governing dynamics of the environment we operate in is significantly more limited. We might have assumptions, theories and models that generally hold and are able to describe relatively well how human psyche, economies, (financial) markets or the weather behave for most of the time. However, in these fields the “cost” of being wrong only once (after being right for an extended period of time!) can completely eliminate all the benefits that were created previously. Actually, it cannot be excluded that this cost will prove to be infinitely negative as it might result in the termination of the organism involved, whether it’s an investor, a human or society or even a complete species.
Our inability to accept this degree of uncertainty is partially what drives our desire for further scientific development. It also seems to trigger a tendency to have more “faith” in the controllability of the world around us than what skeptical look at the empirical evidence suggests is realistic. Numerous financial crisis over the last 20-year have shown what the disadvantage can be from over-confidence in our ability to “model” or estimate financial risk, as it has led to too much faith in our ability to manage or control uncertainty. Actually, it has thereby sowed the seeds of a larger degree of damage done when the unexpected shock hit eventually.
The most important step for dealing with uncertainty is therefore to go against your intuition and embrace it. Acknowledge that a large part of the ecology that we as investors, and as humans, operate in is so complex and, with irregular and low frequencies, so erratic that uncertainty becomes unquantifiable. This is crucial to become more robust in digesting these unexpected dynamics.
The humbling acceptance that the uncertainty-beast is very difficult to tame in the sphere of financial markets (amongst others) is therefore at the cornerstone of our investment philosophy. It guides us in our aim not to under-estimate market risk or over-estimate diversification benefits, it leads our conviction to always balance portfolio risks between “safe” and “return” asset pools. It is also instrumental in our research efforts to identify what type of fundamental and behavioral information provides insight in future market direction in a robust way.